Sources of Economic Growth

The best antidote for most economic ills is considered to be the rapid economic growth. While economists, by and large, tend to agree to the importance attached to economic growth they, however, appear to disagree to the ways of mounting it. There are many things "on heaven and earth" for which economists have no answer and if they have it at all, these are unlikely to 'sing-in unison'. One such area where answers could be numerous is what causes economic growth.

Surprisingly, economists are alleged to know very little about the causes of economic growth. One needs to go back to Nobel laureate Robet Solow's (1950) path-breaking residual factors of productivity analysis to get a cue to growth. Neoclassical growth model, as it is called, the approach pinpoints capital accumulation as the vanguard of fostering rapid growth when savings and investments appear as keys to capital accumulation.

Why save and invest? It is simply because the current generation is exploiting resources for its socio-economic uplift and it should not be oblivious of the fact that the future generation has also a share on these resources. Parents need to sacrifice for children (not perhaps the other way round) and hence "each generation saves just enough to replace the capital that it has depleted". Savings and investments, thus, emerge as the linchpin of sustained economic growth. Hewing in this line of reasoning, perhaps, the Bretton Woods institutions place enormous emphasis on the promotion of these factors. Demand management policies are targeted towards that end.

Available studies tend to show that this simple model, with all its powerful insights into the hike between savings and growth, is constrained by two major drawbacks. First, the specific relationship among some variables as postulated by the model "fails to fit the facts". The example that "income disparities between countries are greater than the differences in their savings rates" is a case in point where the predicted relationship does not hold good. Second, although the model argues that economic growth is a function of the rate of technological change, nevertheless, it fails to explain the determinant of the rate! Again, a poor country might be provided with technology but its poor absorptive capacity might disdain optimum outcome from the use of that technology.

Mr. Mankiw, the growth theorist of Harvard University, appears to treat the neoclassical model as "the model" notwithstanding the limitations cited above. He tends to argue that, for a start, "the goal of growth theory should be to explain why some countries grow faster than others, not why they grow in the first place". Another empirical problem that the model is fraught with, according to Mankiw, is its failure to embrace human capital adjustment. An economy's growth is fuelled by tow sources: the resources deployed for plant and equipment-building and the resources spent on improving workers' skills. The latter is called human capital formation æ the importance of which is recognized by any economist notable among them is Nobel laureate Theodore Schultz. According to the same growth theorist, "in a typical country, about tow-thirds or all labour income derives from such investments. The typical country, therefore, derives about four-fifths of its total income from capital - both human and physical æ as opposed to the one-third share that economists typically assume". Once the contribution of the human capital component is given due cognizance, it could raise the competence of the model to explain growth phenomenon more convincingly. And once the adjustment is made, the neoclassical model outpaces the others in terms of its simplicity to work reasonably well for policymakers and students.

However, an incorporation of the adjustment as mentioned above is being argued to pave ways for more criticisms. In fact, it is being argued that an explicit recognition of the human capital argument raises more questions than answers it can provide. Paul Romer, an expert in growth-theory in Stanford University, estimates that "if differences in income across countries stem from disparate levels of human capital, then returns to education in poor countries should be about 100 times larger than in rich ones which seems one too plausible æ skilled workers should be queuing up at the border of poor countries, not fleeing them for wealthier ones".

In the face of these criticisms, the critics of the neoclassical model share up with "endogenous growth" models æ models that provide explicit recognition on technological change. This school of thought appears to argue that the focus on human capital should be replaces by a focus "on the incentive to create new knowledge and the ways in which this knowledge spreads".

It should, however, be mentioned here that both of these approaches to growth are not immune of deficiencies.

As can be observed, there are a lot of other contributory factors to growth, which the approach apparently tends to undermine. One such factor of importance could be the kind of trade regime in which an economy is being subsided to i.e. whether it is free trade or restricted trade. Even the strength of the legal system could turn out to be the determinant factor. Any model that bypasses these elements is likely to yield partial outcome. Thus like savings rate, schooling, some other factors should bear due weight in growth analysis.